Financial Capability

Financial capability is the ability to make informed decisions about the use and management of money. The goal is to empower individuals with the knowledge, skills, and tools to help them manage their finances. It aims to enhance long-term financial well-being. The term is linked to financial literacy.

Today, individuals have greater responsibility for financial decision-making. Poor credit management may result in higher costs and can affect credit history for years to come. Poor investment decisions regarding retirement plans may have profound effects on a retiree’s financial well-being and independence. Among the negative factors are low contribution rates and inappropriate asset allocation, and failure to start saving for retirement at an early age.

Financial capability is generally lower among the following populations:

• people with low incomes,
• young people,
• women, and
• people from historically disadvantaged racial and ethnic groups.

Many factors can affect financial capability. As the population ages, the number of people with dementia is projected to increase. The financial capability of those who are afflicted will be affected. Research has shown that even absent dementia, an individual’s capability to make financial decisions declines with age. Other factors can affect financial decision-making capability as well. Emotional shocks, such as the loss of a spouse, can significantly affect people’s ability to make clear decisions. Economic shocks, such as job loss and prolonged unemployment, can also affect decision-making.

The number of financial capability programs in the U.S. is growing. Programs vary greatly in content, audience, and goals. It is difficult to measure the effectiveness of these programs in increasing knowledge of managing finances and, more importantly, encouraging sound financial behaviors. However, the Federal Reserve Board has found that increased knowledge may lead to improvements in financial management. More research is needed to understand the true level of impact.

Some states have enacted legislation to promote consumer financial capability. Some laws focus on high school academics. Others establish councils to assess state resources and existing programs. Some programs do both.

Better financial disclosures can be combined with financial capability efforts to increase the likelihood that consumers can understand and compare financial products.